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TESS > SEC Filings for TESS > Form 10-Q on 8-Nov-2012All Recent SEC Filings

Show all filings for TESSCO TECHNOLOGIES INC

Form 10-Q for TESSCO TECHNOLOGIES INC


8-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations. This commentary should be read in conjunction with the Management's Discussion and Analysis of Financial Condition and Results of Operations from the Company's Annual Report on Form 10-K for the fiscal year ended April 1, 2012.

Business Overview and Environment

TESSCO Technologies Incorporated (TESSCO, we, or the Company) architects and delivers innovative product and value chain solutions, at lower costs, to support wireless broadband systems. Although we sell products to customers in many countries, approximately 98% of our sales are made to customers in the United States. We have operations and office facilities in Hunt Valley, Maryland, Reno, Nevada and San Antonio, Texas.

The Company evaluates its business in two segments - commercial and retail. The commercial segment includes: (1) public carriers, contractors and program managers; (2) private system operators and governments; and (3) commercial dealers and resellers. The retail segment includes: (1) retailers, dealer agents and Tier 2 and 3 carriers and (2) Tier 1 carriers (including the Company's largest customer, AT&T).

We offer a wide range of products that are classified into four business categories: base station infrastructure; network systems; installation, test and maintenance; and mobile devices and accessories. Base station infrastructure products are used to build, repair and upgrade wireless telecommunications. Sales of traditional base station infrastructure products, such as base station radios, cable and transmission lines and antennas are in part dependent on capital spending in the wireless communications industry. Network systems products are used to build and upgrade computing and Internet networks. We have also been growing our offering of wireless broadband, network equipment, security and surveillance products, which are not as dependent on the overall capital spending of the industry. Installation, test and maintenance products are used to install, tune, and maintain wireless communications equipment. This category is made up of sophisticated analysis equipment and various frequency-, voltage- and power-measuring devices, replacement parts and components as well as an assortment of tools, hardware and supplies required by service technicians. Mobile devices and accessory products include cellular phone and data device accessories. Our customers generally have the ability to purchase any of our product categories, but base station infrastructure, network systems and installation, test and maintenance products are primarily sold into our commercial segment, while mobile device and accessories products are primarily sold into our retail segment.

Our largest customer relationship, AT&T, a Tier 1 cellular carrier purchasing phone accessories, accounted for approximately 36% of our total revenues during fiscal 2012 and 34% of our total revenues for the first six months of fiscal 2013. Beginning in October 2011, we expanded our business with AT&T, resulting in dramatically increased revenues but significantly lower profit margin. In April 2012, we were notified by AT&T of their intention to transition their third party logistics retail store supply chain business away from us beginning in the second quarter of our fiscal 2013. We now anticipate that this business will be fully transitioned prior to the close of our fiscal 2013, which ends March 31, 2013. This will result in a significant reduction in revenues but, because of the lower margins, and our on-going cost reduction efforts, a lesser relative impact on overall profits in fiscal 2013. During and after the transition, we expect to continue to supply product to this customer's other programs and to supply proprietary Ventev® products to AT&T retail stores. Notwithstanding that the transition has commenced, our AT&T revenues in the second quarter of fiscal 2013 increased significantly as compared to the second quarter of fiscal 2012. However, despite the significant increase, AT&T gross profit was essentially flat in the second quarter this year as compared to the same quarter last year, due to the lower margins associated with this expanded relationship. As a result of the commencement of the AT&T transition during the second quarter of fiscal 2013, revenues and gross profits from this relationship both declined by approximately 17% in the second quarter as compared to the first quarter of fiscal 2013.

Sales of products purchased from our largest vendor, Otter Products, LLC (Otter) generated approximately 10% of our total revenues for the second quarter of fiscal 2013. Much of this concentration, however, is attributable to our mobile device accessory sales to AT&T, which in relation to Otter will be fully transitioned from TESSCO to a third party logistics provider in the third quarter of fiscal 2013. The terms of our current business relationship with Otter are set to expire in March 2013 and as such, we have been engaged in discussions with them regarding revised terms of our relationship. Between now and March 2013 we plan to continue our aggressive marketing and selling of Otter products as a key part of our multi-brand offering and also plan to continue our dialogue with Otter related to future business terms.

Excluding sales to our Tier 1 carriers, second quarter fiscal 2013 revenues increased by 20.7% as compared to the second quarter of fiscal 2012. This growth, combined with a 65.3% increase in sales to our Tier 1 carriers (including AT&T), resulted in total second quarter revenue growth of 32.5% compared to the second quarter of fiscal 2012. Excluding our Tier 1 carriers, gross profit increased by 15.4% in the second quarter of fiscal 2013 as compared to the second quarter of fiscal 2012 and gross profit from our Tier 1 carriers increased 5.6% in the second quarter of fiscal 2013. This resulted in an overall increase in gross profits of 13.6% compared to the second quarter of the prior fiscal year. Selling, general and administrative expenses increased by 6.1% over the prior year quarter. As a result, net income increased by 48.8% and diluted earnings per share increased by 45.5% over the prior-year quarter.

We believe that our recent revenue growth excluding sales to Tier 1 carriers has been, and we expect that it will continue to be, largely driven by the growth in wireless devices. Consumers' demand for these devices is helping to drive opportunities for the sale of our accessory products to our Tier 1 and other retail customers. Also, we believe the growth in wireless devices will require more network build outs which will have a positive impact on our Commercial segment. We continue to see large enterprises, utilities, and governments increasing their use of wireless networks in their businesses and operations.

The wireless communications distribution industry is competitive and fragmented and is comprised of several national distributors. In addition, many manufacturers sell direct. Barriers to entry for distributors are relatively low, particularly in the mobile devices and accessories market, and the risk of new competitors entering the market is high. Consolidation of larger wireless carriers has and will most likely continue to impact our current and potential customer base. In addition, the agreements or arrangements with our customers or vendors looking to us for product and supply chain solutions are typically of limited duration and are terminable by either party upon several months, or otherwise short notice. Our ability to maintain these relationships is subject to competitive pressures and challenges. Because of the nature of our business, we have been affected from time to time in the past by the loss and changes in the business habits of significant customer and vendor relationships, and expect that we will continue to be so affected in the future. We believe, however, that our strength in service, the breadth and depth of our product offering, our information technology system, industry experience and knowledge, and our large customer base and purchasing relationships with approximately 380 manufacturers, provide us with a significant competitive advantage over new entrants to the market.

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Table of Contents

Results of Operations

Second Quarter of Fiscal Year 2013 Compared with Second Quarter of Fiscal Year 2012

Total Revenues. Revenues for the second quarter of fiscal 2013 increased 32.5% as compared with the second quarter of fiscal 2012, largely due to a 53.2% increase in retail segment revenues. The retail sales growth was largely a result of a 65.3% increase in sales to our Tier 1 carrier customers, primarily AT&T, but also due to a 35.4% increase in sales to our non-Tier 1 customers. Commercial segment revenues increased 15.9% compared to the second quarter of fiscal 2012, with a significant increase in sales to our public system operator, contractor and program manager market coupled with lesser increases in our commercial dealer and reseller market as well as our private and government system operator market.

Total Gross Profit. Gross profit for the second quarter of fiscal 2013 increased 13.6% as compared with the second quarter of fiscal 2012, due to a 16.7% increase in our retail segment and a 12.0% increase in our commercial segment. Within the retail segment, our Tier 1 carrier market showed a considerable increase in sales, but much lower gross margins associated with these Tier 1 sales, resulting in a 5.6% increase in gross profit. This was primarily due to the business expansion experienced with AT&T beginning in the third quarter of fiscal 2012. As discussed above, we expect that this business will be fully transitioned prior to the close of our fiscal 2013, which ends March 31, 2013. The increase in our commercial segment gross profit was driven by an increase in all markets, particularly our public system operators, contractors and program managers market. Overall gross profit margin decreased to 19.6%, compared to 22.8% for the same period last year, primarily driven by the temporarily expanded lower margin AT&T business. We account for inventory at the lower of cost or market, and as a result, write-offs/write-downs occur due to damage, deterioration, obsolescence, changes in prices and other causes.

Our ongoing ability to earn revenues and gross profits from customers and vendors looking to us for product and supply chain solutions depends upon a number of factors. The terms, and accordingly the factors, applicable to each relationship often differ. Among these factors are the strength of the customer's or vendor's business, the supply and demand for the product or service, including price stability, changing customer or vendor requirements, and our ability to support the customer or vendor and to continually demonstrate that we can improve the way they do business. In addition, the agreements or arrangements on which our customer and vendor relationships are based are typically of limited duration, typically do not include any obligation in respect of any specific product purchase or sale and are terminable by either party upon several months or otherwise relatively short notice. Because of the nature of our business, we have been affected from time to time in the past by the loss and changes in the business habits of significant customer and vendor relationships, and we may continue to be so affected in the future. Our customer relationships could also be affected by wireless carrier consolidation or the overall global economic environment.

Selling, General and Administrative Expenses. Total selling, general and administrative expenses increased by $1.7 million or 6.1% in the second quarter of fiscal 2013 as compared with the second quarter of fiscal 2012. Selling, general and administrative expenses as a percentage of revenues decreased to 15.2% in the second quarter of fiscal 2013 from 18.9% in the second quarter of fiscal 2012 primarily as a result of a significant increase in revenues with relatively flat compensation and benefits expense.

Pay for performance bonus expense (including both cash and equity plans) increased by $0.6 million in the second quarter of fiscal 2013 as compared to the second quarter of fiscal 2012.

Corporate support expense increased approximately $0.5 million, in the second quarter of fiscal 2013 as compared to the second quarter of fiscal 2012. This increase was primarily related to higher new product development costs as well as slightly higher bad debt expense.

We continually evaluate the credit worthiness of our existing customer receivable portfolio and provide an appropriate reserve based on this evaluation. We also evaluate the credit worthiness of prospective and current customers and make decisions regarding extension of credit terms to such customers based on this evaluation. Accordingly, we recorded a provision for bad debts of $268,800 and $64,400 for the second quarter ended September 30, 2012 and September 25, 2011, respectively. Bad debt expense in the second quarter of fiscal 2012 was unusually low, with the second quarter of fiscal 2013 being much more representative of our historical bad debt expense levels.

Interest, Net. Net interest expense decreased from $72,900 in the second quarter of fiscal 2012 to $12,000 in the second quarter of fiscal 2013, primarily due to decreased borrowings on our revolving line of credit facility.

Income Taxes, Net Income and Diluted Earnings per Share. The effective tax rate increased slightly from 38.5% in the second quarter of fiscal 2012 to 39.6% in the second quarter of fiscal 2013, due to a the Company being subject to income tax in additional state taxing jurisdictions. The cumulative effect of which was accounted for in the current quarter leading to a higher than normal effective tax rate. As a result of the factors discussed above, net income for the second quarter of fiscal 2013 increased 48.8% and diluted earnings per share increased 45.5% compared to the corresponding prior-year quarter.

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Table of Contents

Commercial Segment. Revenues in our commercial segment totaled $95.7 million in the second quarter of fiscal 2013, compared to $82.6 million in the prior year period, a 15.9% increase. Gross profit totaled $24.7 million, a 12.0% increase as compared to the second quarter last year. Within this segment, the commercial dealers and resellers market grew revenues by 14.1% and gross profits by 9.4%. The public carrier, contractor and program manager market had revenue and gross profit increases of 28.6% and 30.8%. The private system operator and government market revenues increased by 9.6% and gross profits by 5.4%.

Our direct expenses in this segment totaled $10.7 million, a 3.7% increase compared to the second quarter of fiscal 2012. Therefore, total segment net profit contribution was $14.0 million, a 19.3% increase over the prior year period.

Retail Segment. Revenues in our retail segment totaled $101.5 million in the second quarter of fiscal 2013, representing a 53.2% increase from the prior year period. Gross profit totaled $14.0 million, a 16.7% increase. Revenues in our retailer, dealer agent and Tier 2/3 carrier market increased in the second quarter of fiscal 2013 as compared to the same period last year, up 35.4%, with a 28.0% increase in gross profit, as a result of increased sales to independent agents and dealers. We experienced significantly higher sales to our Tier 1 carrier market, primarily AT&T, which showed a 65.3% revenue increase, however, due to the lower gross margin associated with this business, gross profit only increased 5.6%.

Our direct expenses in this segment totaled $7.4 million in the second quarter of fiscal 2013, a 10.2% increase over the prior year period. Therefore, total segment net profit contribution was $6.6 million for the second quarter of fiscal 2013, a 25.0% increase over the prior year period.

First Six Months of Fiscal Year 2013 Compared with First Six Months of Fiscal Year 2012

Total Revenues. Revenues for the first six months of fiscal year 2013 compared with the first six months of 2012 increased 24.7%, due to a 10.0% increase in commercial revenues and a 40.4% increase in retail segment revenues. Commercial revenue growth was driven by significant increase in sales to the public system operator, contractor and program manager markets coupled with increases in our commercial dealer and reseller market and our private and government system operator market. The retail sales growth was largely a result of a 50.9% increase in sales to our Tier 1 carrier customers, primarily AT&T, but also due to a 22.4% increase in sales to our non-Tier 1 customers.

Total Gross Profit. Gross profit for the first six months of fiscal year 2013 increased 4.1% as compared with the first six months of fiscal year 2012, due to a 5.0% increase in our commercial segment and a 2.7% increase in our retail segment. Overall gross profit margin decreased to 19.0%, compared to 22.8% for the same period last year, primarily driven by the temporarily expanded AT&T business. Gross profits increased in all markets except for private and government system operators. We account for inventory at the lower of cost or market, and as a result, write-offs/write-downs occur due to damage, deterioration, obsolescence, changes in prices and other causes.

Selling, General and Administrative Expenses. Total selling, general and administrative expenses increased by $0.6 million or 1.1% in the first six months of fiscal year 2013 as compared with the first six months of 2012. Selling, general and administrative expenses as a percentage of revenues decreased to 15.0% for the first six months of fiscal year 2012, as compared to 18.5% in the first six months of fiscal year 2012, resulting from an increase in revenues with a much smaller relative increase in selling, general and administrative expenses. The largest factors contributing to the overall increase in total selling, general and administrative expenses were increased information technology and corporate support costs, partially offset by decreased pay for performance bonus expense due to strong results in the first half of fiscal year 2012.

Pay for performance bonus expense (including both cash and equity plans) decreased by $2.0 million in the first six months of fiscal 2013 as compared to the first six months of fiscal 2012. Our reward programs are performance based, and due to the exceptionally strong first quarter of fiscal 2012, our bonus expense in the first six months of fiscal 2013 was lower compared to the first six months of last year.

Corporate support expense increased approximately $0.6 million, or 18.9%, in the first six months of fiscal 2013 as compared to the first six months of fiscal 2012. This increase was primarily related to slightly higher bad debt expense in addition to higher new product development costs.

Information technology expense increased approximately $0.4 million in the first six months of fiscal 2013 as compared to the first six months of fiscal 2012. This increase was primarily related to investments in business generation technology tools.

We continually evaluate the credit worthiness of our existing customer receivable portfolio and provide an appropriate reserve based on this evaluation. We also evaluate the credit worthiness of prospective and current customers and make decisions regarding extension of credit terms to such customers based on this evaluation. Accordingly, we recorded a provision for bad debts of $483,700 and $76,400 for the six months ended September 30, 2012 and September 25, 2011, respectively. Bad debt expense in the first six months of fiscal 2012 was unusually low due to significant bad debt recoveries, with the first six months of fiscal 2013 being much more representative of our historical bad debt expense levels.

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Interest, Net. Net interest expense decreased from $178,400 in the first six months of fiscal 2012 to $69,400 in the first six months of fiscal 2013, primarily due to decreased borrowings on our revolving line of credit facility.

Income Taxes, Net Income and Diluted Earnings per Share. The effective tax rate increased to 39.3% in the first six months of fiscal year 2013 as compared to 38.4% in the first six months of fiscal year 2012, due to the Company being subject to income tax in additional state taxing jurisdictions. The cumulative effect of which was accounted for in the current year leading to a higher than normal effective tax rate. As a result of the factors discussed above, net income for the first six months of fiscal year 2013 increased 16.8% and diluted earnings per share increased 13.6% compared to the corresponding prior-year quarter.

Commercial Segment. Revenues in our commercial segment totaled $177.0 million in the first six months of fiscal 2013, compared to $160.9 million in the prior year period, a 10.0% increase. Gross profit totaled $46.1 million, a 5% increase as compared to the first six months of last year. Within this segment, the commercial dealers and resellers market grew revenues by 11.8% and gross profits by 8.7%. The public carrier, contractor and program manager market had revenue and gross profit increases of 19.9% and 16.6%. The private system operator and government market revenues increased by 2.1% and gross profits decreased by 4.1%.

Our direct expenses in this segment totaled $20.8 million, a 2.3% increase compared to the first six months of fiscal 2012. Therefore, total segment net profit contribution was $25.3 million, a 7.3% increase over the prior year period.

Retail Segment. Revenues in our retail segment totaled $212.7 million in the first six months of fiscal 2013, representing a 40.4% increase from the prior year period. Gross profit totaled $28.0 million, a 2.7% increase. Revenues in our retailer, dealer agent and Tier 2/3 carrier market increased in the first six months of fiscal 2013 as compared to the same period last year, up 22.4%, with an 18.3% increase in gross profit, as a result of increased sales from independent agents and dealers. We experienced significantly higher sales to our Tier 1 carrier market, primarily AT&T, which showed a 50.9% revenue increase, however, due to the lower gross margin associated with this business, and the beginning of the business transition, gross profit decreased 9.5%.

Our direct expenses in this segment totaled $14.5 million in the first six months of fiscal 2013, a 7.5% increase over the prior year period. Therefore, total segment net profit contribution was $13.5 million for the second quarter of fiscal 2013, a 1.9% decrease over the prior year period.

Liquidity and Capital Resources

The following table summarizes our cash flows provided by (used in) operating,
investing and financing activities for the six months ended September 30, 2012
and September 25, 2011:

                                                                     Six Months Ended
                                                        September 30, 2012       September 25, 2011
Cash flows provided by operating activities            $          3,896,000     $          9,830,400
Cash flows used in investing activities                          (2,539,800 )             (2,448,500 )
Cash flows used in financing activities                          (2,581,900 )             (2,111,800 )
Net (decrease) increase in cash and cash equivalents   $         (1,225,700 )   $          5,270,100

We generated $3.9 million of net cash from operating activities in the first six months of fiscal 2013 compared with $9.8 million generated in the first six months of fiscal 2012. In the first six months of fiscal 2013, our cash provided by operating activities was primarily driven by net income (net of depreciation and amortization and non-cash stock-based compensation expense) plus increases in trade accounts payable, partially offset by increases in inventory and accounts receivable, as well as a decrease in accrued payroll, benefits, and taxes. The increase in accounts payable is largely due to the timing and credit terms of inventory receipts, including the significant increase in inventory during the first six months of fiscal 2013. The increase in inventory is to build inventory for the holiday season and improve service levels to support increased customer demand. The increase in trade accounts receivable is primarily due to the timing of sales and collections, including AT&T sales and collections as well as the fact that we have granted extended payment terms to certain large customers. The decrease in accrued payroll, benefits and taxes was primarily related to the payment of our annual pay for performance bonuses during the first quarter, partially offset by current year bonus accruals.

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Table of Contents

Capital expenditures of $2.5 million in the first six months of fiscal 2013 were up slightly from expenditures of $2.4 million in the first six months of fiscal 2012. In the first six months of fiscal year 2013, capital expenditures were largely comprised of $1.3 million for leasehold improvement expenditures related to our administrative offices and $0.8 million for investments in information technology. In the first six months of fiscal year 2012, capital expenditures were largely comprised of $1.2 million for leasehold improvement expenditures related to our administrative offices and $0.9 million for investments in information technology. A portion of these leasehold improvements expenditures is expected to be reimbursed to us by our landlord during our third fiscal quarter, pursuant to the applicable terms of our lease. When received, these funds will be recorded as deferred rent and will be charged as an offset to rent expense over the remaining term of the lease.

Net cash used in financing activities was $2.6 million for the first six months of fiscal 2013 compared with a net cash outflow from financing activities of $2.1 million for the first six months of fiscal 2012. For the first six months of fiscal 2013 and fiscal 2012, our cash outflow from financing activities was primarily due to cash dividends paid to shareholders as well as repurchases of stock from employees and directors for minimum tax withholdings related to equity compensation, partially offset by the excess tax benefit from stock-based compensation.

We are party to an unsecured revolving credit facility with SunTrust Bank and Wells Fargo Bank, National Association, with interest payable monthly at the LIBOR rate plus an applicable margin. Borrowing availability under this facility is determined in accordance with a borrowing base, and the applicable credit agreement includes financial covenants, including a minimum tangible net worth, minimum cash flow coverage of debt service, and a maximum funded debt to EBITDA ratio. These financial covenants also apply to the separate but related term loan secured by our Hunt Valley, Maryland facility discussed below. The terms applicable to our revolving credit facility and term loan also limit our ability to engage in certain transactions or activities, including (but not limited to) investments and acquisitions, sales of assets, payment of dividends, issuance of additional debt and other matters. As of September 30, 2012, we had a zero balance outstanding on our $35.0 million revolving credit facility; therefore, we had $35.0 million available on our revolving line of credit facility, subject to the limitations imposed by the borrowing base and our continued compliance with the other applicable terms, including the covenants discussed above. On December 30, 2011, we entered into a Sixth Modification Agreement with SunTrust Bank and Wells Fargo Bank, National Association which provided for certain modifications to the provisions applicable to the credit facility, including extending the term from May 30, 2012 to May 31, 2013. We intend to refinance and/or extend this agreement before that date. However, there can be no assurances that we will be able to secure a replacement facility on terms acceptable to us, if at all. . . .

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